• The market has been able to absorb UST supply so far this week; November CPI will be today’s highlight; New York Fed reported November inflation expectations; the FOMC meeting starts today and should end tomorrow with a widely expected hold
  
• Germany ZEW survey for December firmed; the U.K. reported labor market data
  
• Japan Prime Minister Kishida’s popularity is sinking under the weight of a corruption scandal; Japan reported October PPI; reports suggest the annual Central Economic Work Conference in Beijing has ended

The dollar is softer ahead of the CPI data. DXY is trading lower near 103.729 after two straight up days. The euro is trading higher near $1.08 after a firm ZEW survey from Germany (see below), while sterling is trading higher near $1.2570 despite slowing wage growth (see below). USD/JPY is trading lower near 145.30 after its recent bounce ran out of steam near 146.60 yesterday. At this point, it will likely take a string of firm U.S. data to truly challenge the current dovish Fed narrative. Last Friday’s jobs data is a good start, while elevated CPI readings today would likely add to the upward pressure on U.S. yields. We continue to stress that the U.S. economy continues to grow at or above trend even as the rest of the world slips into recession, while price pressures remain persistent enough that the Fed will not be able to cut rates as soon and by as much as the markets think. The dollar should see another leg higher when market expectations for the Fed finally shift, though that may be a 2024 story.

AMERICAS

The market has been able to absorb UST supply so far this week. Treasury auctioned $50 bln of 3-year notes and $37 bln of 10-year notes yesterday and the results were mixed. Demand was soft for the 3-year auction, as indirect bidders took 52.1% vs. 64.6% at the previous auction while the bid/cover ratio was 2.42 vs. 2.67 previously for a yield of 4.49% vs. 4.701% previously. However, the 10-year auction saw slightly better demand as indirect bidders took 63.8% vs. 69.7% at the previous auction while the bid/cover ratio was 2.53 vs. 2.45 previously for a yield of 4.296% vs. 4.519% previously. Yields are lower on the week, but Treasury still has $21 bln of 30-year bonds to auction today. We are still looking for a hawkish hold from the Fed Wednesday and believe yields should move higher from current depressed levels.

November CPI will be today’s highlight. Headline is expected to fall a tick to 3.1% y/y while core is expected to remain steady at 4.0% y/y. Of note, the Cleveland Fed’s Nowcast model has headline and core at 3.0% and 4.1% in November followed by 3.3% and 4.0% in December, respectively. With CPI readings likely to pick up into year-end, this will test the market’s faith in the dovish Fed narrative.

The New York Fed reported November inflation expectations. 1-year expectations fell to 3.4% vs. 3.6% in October to the lowest since April 2021. However, 3-year expectations were steady at 3.0% and 5-year expectations were steady at 2.7%. The Fed won't be happy about this since it means inflation is expected to remain above the 2% target for an extended period of time.

The FOMC meeting starts today and should end tomorrow with a widely expected hold. However, we expect a hawkish hold with the Fed pushing firmly back against the elevated rate cut expectations. WIRP suggests no change either this week or in January but after that, it’s all about the cuts. There are 50% odds of a cut March 20 and is fully priced in May 1. Four cuts are fully priced in by end-2024, with nearly 60% odds of a fifth one. While we disagree with this market pricing, it will take a string of stronger data to shift the narrative.

New macro forecasts and Dot Plots will be released. Of note, the extra hike in 2023 that was seen in September will be taken out so the 2023 Dot will fall to 5.375%. Will the 2024 Dot stay at 5.125% (one cut implied) or move down to 4.875% (two cuts)? Either one would suggest limited scope for rate cuts next year. We certainly don’t expect a more dovish 2024 Dot of 4.625% (three cuts), as this would simply feed into the dovish Fed narrative. The 2025 and 2026 Dots have little meaning right now and are unlikely to shift much. Growth forecasts are likely to be revised marginally higher while inflation and unemployment forecasts are likely to be revised marginally lower.

Chair Powell’s press conference is typically important. However, the markets really didn’t respond to his hawkish comments right before the blackout period began. Recall that Powell said the Fed was prepared to tighten more if it became appropriate and stressed that it was premature to speculate on when the Fed might ease. He said policy is “well into restrictive territory” and that the Fed is committed to staying restrictive until inflation is on a path to the 2% target. Really, it's become a little too late for Powell and the Fed to change a narrative that's become so ingrained in the markets that it will take several stronger than expected data reports to change it.

Other minor data will be reported today. November NFIB small business optimism is expected to remain steady at 90.7. Elsewhere, the November budget deficit is expected at -$317.0 bln vs. -$66.6 bln in October.

EUROPE/MIDDLE EAST/AFRICA

Germany ZEW survey for December firmed. Expectations came in at 12.8 vs. 9.5 expected and 9.8 in November, while current situation came in at -77.1 vs. -76.0 expected and -79.8 in November. Expectations rose for the fifth straight month to the highest since March. ZEW noted that “Despite the current budget crisis, the assessment of the situation and economic expectations for Germany have once again increased slightly. That’s helped by the fact that the proportion of respondents who expect the ECB to cut rates in the medium term has doubled.” Survey readings in the eurozone have been improving recently but the hard data remain weak.

The two-day European Central Bank meeting ends Thursday with a widely expected hold. Despite efforts to push back against the market, easing expectations have picked up. WIRP suggests 5% odds of a cut this week, rising to 10% January 25, 60% March 7 and fully priced in April 11. Five cuts by the end of next year are fully priced in. The bank will discuss adjusting both its PEPP reinvestments and its Minimum Reserve Requirements. ECB hawks have been pushing for changes to both of these sooner rather than later. While the bank may give some hints of these discussions, we do not think a decision on either will be made until 2024.

The U.K. reported labor market data. Average weekly earnings for the three months ending in October came in at 7.2% y/y vs. 7.7% expected and a revised 8.0% (was 7.9%) previously. This was the lowest since the three months ending in May and will be welcomed by the BOE as the ONS noted that “While annual growth in earnings remains high in cash terms, there are some signs that wage pressure might be easing overall.” The ONS continues to estimate a new experimental unemployment rate, which remained steady at 4.2% for the three months ending in October.

The data come ahead of the Bank of England decision Thursday. The softer wage data support a widely expected hold. WIRP suggests no odds of a hike this week, rising modestly to top out near 5% February 1. After that, rate cuts are priced in. WIRP suggests 15% odds of a cut March 21, rising to 50% May 9 and fully priced in June 20. Three cuts are priced in by the end of 2024.

ASIA

Japan Prime Minister Kishida’s popularity is sinking under the weight of a corruption scandal. The latest poll from NHK shows his support falling to 23% as several members of his LDP faction appear to be involved in concealing fundraising proceeds in a slush fund. Prosecutors are expected to launch an investigation soon but four of Kishida’s ministers are likely to step down, including Chief Cabinet Secretary Matsuno and Trade Minister Nishimura.

Japan reported October PPI. PPI rose the expected 0.2% m/m vs. a revised -0.3% (was -0.4%) in September, while the y/y rate came in at 0.3% vs. 0.1% expected and a revised 0.9% (was 0.8%) in September. This was the lowest y/y gain since February 2021. Price pressures continue to ease, giving the Bank of Japan leeway to keep policy on hold for now. Liftoff expectations have eased a bit ahead of its December 18-19 meeting. WIRP now suggests only 10% odds of a move then vs. 35% last week, as the soft data have provided a bit of a reality check for the markets. Not only PPI, but also weak wage growth, lower than expected November Tokyo CPI data, and downward revisions to Q3 GDP data all argue for caution in removing accommodation too soon. Still, expected liftoff remains stuck in April vs. June at the start of last week.

Reports suggest the annual Central Economic Work Conference in Beijing has ended. President Xi and other top leaders reportedly discussed the 2024 growth target at the conference, which state-run media finally confirmed began Monday. Many believe this year’s target will be close to this year’s goal of “around” 5%. Of note, the IMF forecasts China will grow 5.0% this year and 4.2% next year but neither of those numbers are very believable.